Financial inclusion means every adult having access to fair and affordable savings, transactional banking, credit and insurance. It also requires consumers of financial services to be literate around their use. Whilst this sounds unobjectionably positive, expanding access to financial products can create new risks for financial institutions, financial stability and the financially excluded themselves. Policymakers around the world are grappling with how to balance financial stability with the broader goal of financial inclusion, and have responded in different ways. We believe central banks both in developed and developing countries can play a valuable role in promoting financial inclusion and that they need to consider financial inclusion if they are to promote the good of all the people they serve.

Financial exclusion is not just caused by poverty but can actually create a vicious circle that keeps people in it. In the UK, it is estimated that individuals forced to rely on cash transactions pay a “poverty premium” of up to £1,300 per year. In addition, the introduction of Universal Credit creates a pressing need for greater inclusion as it will require benefit recipients to have a formal bank account.

The FIC report makes for sober reading. As well as the nearly 2 million adults in the UK without a bank account, 13 million people don’t have enough savings to sustain themselves over a month if they experienced a 25% drop in income. And half of all low-income households don’t have household contents insurance.

Perhaps most surprising is that more than half of the nearly 2 million adults without a bank account prefer not to have one. In many cases this appears to be because people are put off by potentially high penalty fees and charges, especially if they have had negative experiences with banks in the past. In other cases it seems to reflect a wider public distrust of banks following the financial crisis, and an unwillingness to act as creditors (depositors) to them.

So while exclusion has significant costs, many people actually perceive disadvantages in being financially included, which raises the question of how best to pursue financial inclusion if it is an explicit policy goal. Below we discuss some of the advantages and disadvantages of greater financial inclusion and different paths towards its achievement. Achieving full inclusion will require a combination of top-down and bottom-up solutions that reflect the preferences of the financially excluded. We also set out various roles central banks can play.

Increasing financial access for individuals

Increasing access to finance affects individuals’ financial health in sometimes conflicting ways. On the one hand, savings accounts, some insurance products and even affordable credit can help households withstand unexpected shocks such as unemployment or medical emergencies. This in turn can help reduce wealth inequality, positively influencing long-term economic growth and absolute poverty reduction.

On the other hand, increasing access to credit is not universally beneficial. In some cases debt may paper over wider inequalities without addressing their root causes (i.e. access to credit as a poor substitute for growth in real wages). Credit can also create a spiral of debt where successive loans are made simply to repay interest from previous loans. In fact, more than 12,000 of the 70,000 people who sought help with payday loan debt in 2014 at StepChange, a UK debt charity, had five or more loans.

The impact of greater financial inclusion on financial firms like banks is equivocal. On the one hand, widening access to transactional and savings accounts does not appear to impact financial stability adversely. In fact, it can broaden banks’ funding bases and low-income-household deposits also have been shown to be relatively stable with low volatility. Similarly, broadening lending operations by extending credit could enable banks to diversify their assets, which could positively impact long-term profitability.

One way they can do so is ensuring financial regulation does not stifle innovation. Much has been made of the impact of capital requirements on financial institutions’ ability to develop and extend products and services that benefit those currently excluded. But financial regulation also influences institutions through other channels. This includes hard influences such as via authorisations, permissions and requirements, and also soft influences via correspondence and discussion. Explicitly considering financial inclusion in all of these settings could make a significant difference to financial institutions’ interest and ability to tackle financial exclusion.

Many central banks across the globe provide useful examples of what can be done to promote greater inclusion. Some central banks collect valuable data on financial exclusion in order to establish evidence on what works. Others provide financial literacy training to improve the usage of financial services or promote better infrastructure to reach the excluded. Thinking outside the box, central banks could even offer basic current accounts and other services directly to the financially excluded as a step to bring people into the financial system. In the UK, this might be especially effective for the 1 million adults who choose to remain unbanked due to previous negative experiences with the private sector.

In sum, central banks inevitably have an effect on financial inclusion and we think they should explicitly consider this effect when setting policy. The best ways for central banks to influence financial inclusion are still open to debate. Currently, in the UK, we believe emphasis should be on promoting universal access to transaction and savings products.

David Bholat works in the Bank’s Advanced Analytics Division, Julia Kowalski works in the Bank’s Major UK Banks Division and Simon Milward works in the Bank’s Major UK International Banks Division.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England or its policy committees.

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